ABSTRACT: When the winner of one auction gains a cost advantage in the next, bids reflect
not only the value of winning the auction, but also the value of gaining an
incumbent advantage in future auctions. If a larger firm's advantage derives
from a cost or product advantage, it has a greater chance of holding onto
incumbency status which, in turn, increases the value it places on gaining
incumbency. As a consequence, larger firms bid more aggressively than their
smaller rivals, where "size" is measured by the probability of winning. In this
environment, mergers eliminate competition among the merged firms but they also
change bidding behavior by both merging and non-merging firms. Computational
experiments suggest that the scope for pro-competitive mergers is much wider
than in auctions without an incumbent advantage. In particular, mergers among
smaller firms are likely to be pro-competitive because they tend to create
better losers, i.e., firms who bid more aggressively but still lose a large part
of the time.